It's the Economy

The price of oil continues to be a drag on the economy. With the stock of oil on hand at the lowest level in three decades, the oil companies are betting on the war to be brief with no damage to Iraq’s oil facilities, so they won’t need to replace stocks at current prices. (Price gouging?) Regardless of the outcome of the war, the economy will continue to struggle. The best war scenario is that Iraq will quickly surrender and that there is no damage to the Iraqi oil fields. This seems doubtful given Saddam’s history, unless his supporters overthrow him.

That the Federal Reserves seems unsure about the strength of the economy suggests that the recovery is still in doubt. Like everyone, they are waiting to see the impact of the war rather than reducing the rate unnecessarily at this time.

Bush has already lost the propaganda battle regarding Iraq. If chemical or biological weapons were found it would be argued that given time the arms inspectors would have discovered them. A quick victory in the war with Iraq would ease some of the uncertainty about threats to the US economy and may well result in greater capital investments and hiring of employees. However, the war will not solve the problem of over capacity in most industries for the US as well as much of the rest of the world.

A quick victory would also allow the Administration to concentrate on an economic stimulus package. The earlier proposed tax cuts will have little impact on kick-starting the economy and could have a negative impact. Instead, a package of tax cuts and domestic infrastructure spending, with low interest rates, would likely have a positive impact.

Those who think the war will be good for the economy are sure to be disappointed. The cost of the war and the cost of the peace will be a drag on the domestic economy. Already the cost and disruptions caused by the homeland security effort and the high price of oil are a drag on economic activity. The war will not only require US aid, it will also distract the Administration from directing its efforts to revitalizing the US economy.

The Stock Market

The recent run up in the markets has come somewhat as a surprise. It was not entirely unexpected, as the analyst seems to expect the economy and the stock markets to react the same as they did after the earlier Gulf War. Given the volume, the run-up in stocks is not impressive when short covering is considered.

The general myth is that wars are good for the economy. Not true. Whether this war will help the world economy will depend on what happens with the oil fields. If much damage occurs and Iraqi oil exports are disrupted, the price of oil could remain well above the current level for months. Unlike in the early 1990s, the oil industry has little excess oil capacity to replace production from Iraq.

While the US economy is less dependent on oil now than in the past, a high price for oil acts similar to a tax, reducing consumers ability to buy goods and services and increasing costs to industry. The impact of this war could be particularly hard on the airline industry, which is already reeling from losses. If the war is not over quickly the economy will continue to suffer and stocks will retreat from their current levels.

This recent run-up in stocks offers the investors the opportunity to protect themselves from a correction down to previous levels. Place stop loss orders for stocks you may be less than enthused about for the long haul. After the enthusiasm ends, expect the market to test recent lows.